Reminder: California Requires Use of Tax Basis Method to Compute Owners’ Capital Account Balances for Tax Year 2023

Pursuant to FTB Notice 2023-01, beginning in tax year 2023, California requires partnerships filing a California Form 565 and limited liability companies taxed as partnerships filing a California Form 568 (collectively, pass-through entities) to report their owners’ capital accounts on the California Schedule K-1 using the tax basis method as determined under California law. This is a change from California’s prior position, which allowed pass-through entities to use the federal capital account balances for California tax purposes. Compliance with this new requirement may be complex and data-intensive, and failure to comply could result in unfavorable consequences.

BDO Insights

  • Although all pass-through entities filing a California Form 565 or 568 must comply with FTB Notice 2023-01 for tax year 2023, compliance may be more complex for pass-through entities in multi-tiered structures, given the lack of historical data and other information for older years. Pass-through entities might have to gather data for the entire period in which their owners held interests in them, which could cover the entire period in which they existed. Further, pass-through entities may be required to identify differences between federal and California tax laws over that same period to properly account for adjustments in the California calculation.
  • California is requiring the inclusion of a statement with the California Schedule K-1 that discloses specified information, including the methodology used to comply with the new California requirement.